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Learning Objectives
LO 7-1 Review the strategic objectives of a retail firm.
LO 7-2 Contrast the two paths to financial performance using the strategic
profit model.
LO 7-3 Illustrate the use of the strategic profit model for analyzing growth
opportunities.
Financial Strategy
LO 7-4 Review the measures retailers use to assess their performance.
CHAPTER 7

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Objectives and Goals Strategic Profit Model 1

Learning Objective 7-1 Review the strategic objectives of a retail firm. Learning Objective 7-2 Contrast the two paths to financial performance using the strategic profit model.

Financial Objectives Strategic Profit Model

• Appropriate measure is return on assets (ROA). A method for summarizing the factors that affect a firm’s financial
performance, as measured by return on assets.
Societal Objectives
Net profit margin (in percent).
• Make the world a better place to live.
• How much profit a firm makes divided by net sales.
• More difficult to measure.
Asset turnover.
Personal Objectives • Retailer’s net sales divided by its assets.
• Especially for small, independent businesses. ROA determined by multiplying these two things together.
• Self-gratification, status, respect.
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EXHIBIT 7-2 Different Approaches for Achieving

EXHIBIT 7-1 Strategic Profit Model
an Acceptable ROA

Net Profit Margin × Asset Turnover = Return on Assets

La Chatelaine Bakery 1% 10 times 10%

Lehring Jewelry 10% 1 times 10%

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Determining ROA Strategic Profit Model 2

Profit Margin Management Path
Income statement.
• Also called statement of operations or profit and loss (P&L) statement.
• Summarizes a firm’s financial performance over a period of time, typically a quarter
(three months) or year.

La Chatelaine Bakery is a low-profit-margin/high-turnover operation, whereas

Lehring Jewelry is a high-profit-margin/low-turnover operation. But both
stores have the same return on assets (ROA).

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EXHIBIT 7-3 Income Statements for EXHIBIT 7-4 Profit Management Path of
Target and Walmart Strategic Profit Model
Target Income Walmart Income
Statement (FY 2/1/2020) Statement (FY 1/31/2020)
Net sales $77,130 $519,926
Less cost of goods sold (COGS) 54,864 394,605
Gross margin 22,266 125,321
Less operating expenses (SG&A) 18,590 108,791
Operating profit margin 3,676 16,530
Less other income (interest, taxes) 1,377 5,687
Net profit margin 2,299 10,843
Ratios
Gross margin as a percentage of sales 28.87% 24.10%
Operating expenses as a percentage of 24.10% 20.92%
sales
Operating profit margin as percentage of 4.77% 3.18%
sales
Net profit margin as a percentage of sales 2.98% 2.09% Access the text alternative for slide images.

Source for Walmart: U.S. Securities and Exchange Commission Form 10-K Fiscal Year ended January 31, 2020.
© McGraw Hill LLC Source for Target: U.S. Securities and Exchange Commission Form 10-K Fiscal Year ended February 1, 2020. 9 © McGraw Hill LLC 10

Strategic Profit Model 3 Strategic Profit Model 4

Profit Margin Management Path continued Profit Margin Management Path continued
Components in the Profit Margin Management Path: Components in the Profit Margin Management Path continued
• Net sales. • Operating expenses.
• Cost of goods sold (COGS). • Also called selling, general, and administrative expenses (SG&A).

• Gross margin. • Operating profit margin.

• Gross profit. • Net profit margin or net income.
• Slotting fee or allowance.
• Chargeback fee.

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Costs of Online Channels Strategic Profit Model 5

Profit Margin Management Path continued
Analyzing Performance in the Profit Margin Management Path:
• Gross margin (in %).
The retailer’s cost to sell
• Operating expenses (in %).
a pair of jeans online is
• Operating profit margin (in %).
higher than in a store
because of shipping,
handling, and returns.

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Strategic Profit Model 6 EXHIBIT 7-5 Balance Sheets for Target and Walmart 1

Asset Turnover Management Path

Target (FY 2/1/2020) Walmart (FY 1/31/2020)
Assets are economic resources (inventory, buildings, computers, fixtures) Assets
owned or controlled by a firm. Cash and cash equivalents $2,577 $9,465
Current Assets. Merchandise inventory 8,922 44,380
Other current assets 1,333 7,906
• Cash and cash equivalents.
Total current assets 12,902 61,751
• Merchandise inventory.
Property and equipment 26,283 105,208
• Accounts receivable. (net)
Other noncurrent assets 3,594 69,481
• Inventory turnover.
Total noncurrent assets 29,877 174,689
Total assets $42,779 $236,495

© McGraw Hill LLC 15 © McGraw Hill LLC Sources: Target: U.S. Securities and Exchange Commission Form 10-K Fiscal Year ended February 1, 2020; Walmart: U.S. Securities and Exchange Commission Form 10-K Fiscal Year ended January 31, 2020. 16

EXHIBIT 7-6 Asset Turnover Management Path

EXHIBIT 7-5 Balance Sheets for Target and Walmart 2
in Strategic Profit Model
Target (FY 2/1/2020) Walmart (FY 1/31/2020)
Ratios
Inventory turnover 6.10% 8.89%
P&E Turnover 2.93% 4.94%
Asset turnover 1.80% 2.20%
ROA 5.37% 4.58%

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Strategic Profit Model 7 Strategic Profit Model 8

Asset Turnover Management Path continued Combining the Profit Margin and Asset Turnover Management Paths
Noncurrent assets are assets not likely to be converted to cash within one Target has higher operating profit margin and performs better than Walmart
year. on profits.
• Fixed assets. • Target attains better overall performance, as measured by ROA.
• Intangible assets. Walmart has higher asset turnover.
Analyzing the performance of the asset management path. • More efficient asset turnover rate than Target.
• Asset turnover (net sales divided by total assets) provides a relevant measure.

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Strategic Profit Model 9 Evaluating Growth Opportunities 1

Learning Objective 7-3 Illustrate the use of the strategic profit model for analyzing growth opportunities.
Implications for Improving Financial Performance
• Profit management path: profit margin increased by increasing sales or
reducing COGS, operating expenses. Profit Margin Management Path
• Asset management path: increase asset turnover by decreasing dollar Assumes store sales will remain the same after introduction of Internet
amount of inventory in stores but less inventory could lead to fewer sales. channel.
• Gross margin.
• Need to consider both operating and net profit margin and asset turnover
when evaluating financial performance. • Operating expenses.
• Net operating profit margin.
• Need to consider implications of strategic decisions.
Example: Gifts-To-Go stores.

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EXHIBIT 7-7 Income Statement Information of Analysis of

Gifts To Go Growth Opportunities
Evaluating Growth Opportunities 2
Gifts to Go Gifts-To-Go.com Businesses
Income Statements Stores (projected) Combined
Asset Turnover Management Path
Net sales $700,000 $440,000 $1,140,000 • Estimates Gifts-To-Go.com will have higher inventory turnover than stores.
Less: Cost of goods sold 350,000 220,000 570,000
Gross margin 350,000 220,000 570,000
• Vendors will “drop ship” orders so reduces inventory.
Less: Operating expenses 250,000 150,000 400,000
Operating profit 100,000 70,000 170,000
Less: Interest Expenses & Taxes 40,000 24,000 64,000
Net profit margin $60,000 $46,000 $106,000
Ratios
Gross margin 50% 50% 50%
Operating expense 35.7% 34.1% 35.1%
Operating profit 14.3% 15.9% 14.9%
Net profit margin 8.6% 10.5% 9.3%

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EXHIBIT 7-8 Balance Sheet Information of Analysis of

Gifts To Go Growth Opportunities
Growth Options

Gifts to Go Stores Gifts-To-Go.com Businesses

(projected) Combined
Cash $175,000 $131,000 $306,000
Merchandise inventory 175,000 70,000 245,000
Total current assets 350,000 201,000 551,000
Fixed assets 30,000 10,000 40,000
Total assets 380,000 211,000 591,000
Ratios
Inventory turnover 2.00 3.14 2.33
Asset turnover 1.84 2.09 1.93
ROA 15.8% 21.8% 17.9%

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Evaluating Growth Opportunities 3 Setting and Measuring Performance Objectives 1

Learning Objective 7-4 Review the measures retailers use to assess their performance.
Using the Strategic Profit Model to Analyze Other Decisions
Gifts-To-Go could install computerized inventory control system.
Performance Objectives
• Increase sales.
• Numerical index of performance desired.
• Gross margin percentage will increase.
• Increase fixed assets. • Time frame to achieve objective.
• Asset turnover will probably increase. • Resources needed to achieve objective.
• Total assets may actually decrease.

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Setting and Measuring Performance Objectives 2 Setting and Measuring Performance Objectives 3
Top-Down versus Bottom-Up Process Who is Accountable for Performance?
• Top-down planning means goals are set at top of organization and passed • Business unit and managers accountable for revenues, expenses, cash
down to lower operating levels. flow, and contribution to ROA they can control.
• Bottom-up planning involves lower levels in company when developing • Performance objectives and measures used to pinpoint problem areas.
performance objectives that are then aggregated up. • Actual performance may differ from prediction due to unpredictable
circumstances.

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Setting and Measuring Performance Objectives 4 Setting and Measuring Performance Objectives 5
Performance Objectives and Measures Types of Measures
Difficult to find single measure to evaluate performance. Output measures.
Measures vary depending on: • Assess results of investment decisions.

• Level of organization at which decision is made. Productivity measure.

• Resources the manager controls. • Determines how effectively retailers use resources.
• Useful for comparing the performance of different business units.

Input measures.
• Resources allocated to achieve outputs.

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EXHIBIT 7-9 Measure for Assessing the EXHIBIT 7-9 Measure for Assessing the
Performance of Retailers 1 Performance of Retailers 2

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Setting and Measuring Performance Objectives 6 Setting and Measuring Performance Objectives 7
Types of Measures continued Assessing Performance: The Role of Benchmarks
Corporate performance. Performance cannot be assessed accurately simply by looking at isolated
• Comparable-store sales growth. measures.
• Same-store sales growth. Two common benchmarks:
Merchandise management measures. • Performance of retailer over time.

• Set and lower prices. • Performance of retailer compared to competition.

• Negotiate with vendors over price of merchandise.

Store operations measures.

• Sales per square foot of selling space.
• Sales per employee.

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Key Terms 1 Key Terms 2

assets – economic resources, such as inventory or store fixtures, owned or controlled by an cost of goods sold (COGS) – the fee the retailer pays a vendor for merchandise that the
enterprise as a result of past transactions or events. retailer sells.
asset turnover – net sales divided by total assets. current assets – cash or any assets that can normally be converted into cash within one year.
bottom-up planning – when goals are set at the bottom of the organization and filter up gross margin – the difference between the price the customer pays for merchandise and the
through the operating levels. cost of the merchandise (the price the retailer paid the supplier of the merchandise). More
specifically, gross margin is net sales minus cost of goods sold. Also called gross profit.
cash and cash equivalents – currency, checks, short-term bank accounts, and investments
that mature within three months or less. gross margin (in %) – gross margin divided by net sales expressed as a percentage.
chargeback fee – the fee that retailers require vendors to pay when the provided merchandise gross profit – the difference between the price the customer pays for merchandise and the cost
does not meet the terms of the purchase agreement. of the merchandise (the price the retailer paid the supplier of the merchandise). more
specifically, gross profit is net sales minus cost of goods sold. also called gross margin.
comparable-store sales growth – the sales growth in stores that have been open for over one
year. Also called same-store sales growth. income statement – a summary of the financial performance of a firm for a certain period of
time. Also called a statement of operations or profit and loss statement.

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Key Terms 3 Key Terms 4

input measure – a performance measure used to assess the amount of resources or money net profit margin (in %) – refers to profit after taxes, interest income, and extraordinary gains
used by the retailer to achieve outputs. and losses a firm makes divided by its net sales expressed in percentage terms.
intangible assets – nonphysical assets such as patents and goodwill. net sales – the total number of dollars received by a retailer after all refunds have been paid to
customers for returned merchandise.
inventory turnover – net sales divided by average retail inventory; used to evaluate how
effectively managers utilize their investment in inventory. noncurrent assets – assets that are not likely to be converted to cash within one year.
merchandise inventory – the goods the retailer invests in and holds in stock, to enable operating expenses – costs, other than the cost of merchandise, incurred in the normal course
customers to find what they want in the right place at the right time. of doing business, such as salaries for sales associates and managers, advertising, utilities,
office supplies, and rent. Also called selling, general, and administrative (SG&A) expenses.
net income – calculated as: operating profit margin – other income or expenses – interest -
taxes. Also called net profit margin. operating expenses (in %) – operating expenses divided by net sales expressed in
percentage.
net profit margin – calculated as: operating profit margin – other income or expenses – interest
- taxes. Also called net income. operating profit margin – the gross margin minus the operating expenses.
operating profit margin (in %) – the gross margin minus the operating expenses divided by
net sales expressed as a percentage.

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Key Terms 5 Key Terms 6

output measure – measure that assesses the results of retailers’ investment decisions. slotting allowance – fee paid by a vendor for space in a retail store. Also called slotting fee.
productivity measure – the ratio of an output to an input determining how effectively a firm slotting fee – fee paid by a vendor for space in a retail store. Also called slotting allowance.
uses a resource.
statement of operations – a summary of the financial performance of a firm for a certain period
profit and loss (P&L) statement – a summary of the financial performance of a firm for a of time. Also called an income statement or profit and loss (P&L) statement.
certain period of time. Also called an income statement or statement of operations.
strategic profit model (SPM) – a tool used for planning a retailer’s financial strategy based on
return on assets (ROA) – net profit after taxes divided by total assets. both margin management (net profit margin) and asset management (asset turnover). Using
the SPM, a retailer’s objective is to achieve a target return on sales.
same-store sales growth – the sales growth in stores that have been open for over one year.
Also called comparable-store sales growth. top-down planning – one side of the process of developing an overall retail strategy where
goals are set at the top of the organization and filter down through the operating levels.
selling, general, and administrative expenses (SG&A) – costs, other than the cost of
merchandise, incurred in the normal course of doing business, such as salaries for sales
associates and managers, advertising, utilities, office supplies, and rent. Also called
operating expenses.

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